Estate Tax Minimization: $1 Million Increase in Tax-Free Transfers

Estate Tax Minimization: $1 Million Increase in Tax-Free Transfers

Executive Summary

A high-net-worth client approached Golden Door Asset seeking strategies to minimize their estate tax liability and maximize the inheritance for their children. Facing a rapidly appreciating portfolio primarily composed of real estate and privately held stock, the client was concerned about exceeding the federal estate tax exemption. Through a combination of strategic gifting and the implementation of an irrevocable life insurance trust (ILIT), Golden Door Asset helped the client increase the amount of assets transferable tax-free by $1 million, significantly improving the financial future of their heirs.

The Challenge

Our client, a successful entrepreneur in the tech sector, had amassed a substantial estate valued at approximately $12 million. A significant portion of this wealth, around $7 million, was tied to the value of their privately held company stock, which was projected to appreciate considerably within the next 5-7 years based on industry analysts' reports and internal growth projections. The remaining assets consisted of real estate holdings ($3 million) and liquid investments ($2 million).

The client’s primary goal was to minimize estate taxes upon their death, allowing their two adult children to inherit as much of the estate as possible. They were particularly concerned because their current estate was already approaching the federal estate tax exemption amount (which was $12.92 million per individual in 2023, and is scheduled to revert to lower levels without legislative action). With the anticipated appreciation of their company stock, projections showed their estate could easily exceed $16 million within the next five years, exposing a significant portion of their wealth to a 40% federal estate tax.

The client had previously consulted with other advisors who suggested simple gifting strategies, but these were insufficient to address the projected estate tax liability. Furthermore, the client was hesitant to relinquish control of their company stock completely during their lifetime. They needed a more sophisticated and comprehensive estate planning approach that balanced their desire to retain control while minimizing future tax burdens. Their existing estate plan, drafted five years prior, was outdated and did not account for the significant growth in their net worth. They were seeking a solution that provided both immediate tax benefits and long-term security for their family. They also expressed concern about potential liquidity issues for their heirs to pay estate taxes on remaining assets.

The Approach

Patricia Brennan, a senior estate planning specialist at Golden Door Asset, developed a multi-faceted strategy to address the client's concerns and achieve their estate planning goals. This involved a combination of strategic gifting and the creation of an irrevocable life insurance trust (ILIT).

First, we advised the client to leverage annual gifting exclusions. In 2023, individuals could gift up to $17,000 per recipient without incurring gift tax or using up their lifetime gift exemption. The client had two children and four grandchildren, allowing them to gift a total of $102,000 annually ($17,000 x 6) to these beneficiaries. While this was a relatively small amount compared to the overall estate value, it provided a consistent method for reducing the taxable estate over time.

The cornerstone of the strategy was the establishment of an ILIT. The client funded the ILIT with annual exclusion gifts. The ILIT then purchased a $2 million life insurance policy on the client. Critically, the life insurance proceeds would not be included in the client's taxable estate because the ILIT owned the policy.

We also advised the client to make larger gifts using a portion of their lifetime gift tax exemption. Given the projected appreciation of the company stock, it was advantageous to gift shares of the stock now, before its value increased further. The client gifted approximately $500,000 worth of company stock to a Grantor Retained Annuity Trust (GRAT) for a term of two years. The GRAT allows the client to receive an annuity payment each year, while any appreciation above the IRS's hurdle rate will pass to the client’s children free of gift and estate tax. This strategy allowed for shifting future appreciation out of the estate, leveraging the current lower valuation of the stock.

Finally, we recommended a complete review and update of the client’s will, powers of attorney, and healthcare directives to ensure consistency with the new estate plan. This included clearly defining the beneficiaries of the ILIT and the distribution of assets within the trust. The entire plan was designed to create a cohesive and legally sound framework for managing the client’s wealth and ensuring a smooth transfer to their heirs.

Technical Implementation

Golden Door Asset leveraged its AI-powered platform to conduct detailed actuarial analyses and financial projections to optimize the estate planning strategy.

• Life Insurance Policy Optimization: We used our proprietary algorithms to model different life insurance scenarios, considering factors such as the client's age, health, and life expectancy. The models analyzed various policy types (term, whole life, universal life) and premium payment structures to determine the most cost-effective and tax-efficient option. We ultimately recommended a guaranteed universal life policy for its flexibility and tax advantages within the ILIT structure. The face value of $2 million was carefully calculated to provide sufficient liquidity to cover potential estate tax liabilities on the remaining assets and any potential expenses incurred by the estate.

• GRAT Modeling and Valuation: Our platform incorporates valuation models for closely held businesses, which allowed us to estimate the fair market value of the client's company stock with a high degree of accuracy. We also used our AI-powered Monte Carlo simulation engine to project the future appreciation of the stock under various economic scenarios. This allowed us to determine the optimal amount of stock to gift to the GRAT and the appropriate annuity payment schedule to maximize the tax benefits. We considered the IRS’s applicable federal rate (AFR) for the duration of the GRAT to ensure that it was structured in a manner that would successfully shift wealth out of the estate.

• Tax Liability Projections: We used our tax planning software to project the client's estate tax liability under different scenarios, taking into account the federal estate tax exemption, applicable state estate taxes (if any), and the impact of the gifting and ILIT strategies. These projections were updated regularly to reflect changes in the client's net worth, tax laws, and economic conditions. We specifically modelled the potential impact of the estate tax exemption reverting to its pre-2018 levels to illustrate the importance of proactive planning.

• ILIT Document Review and Implementation: Our legal team collaborated with the client's attorney to draft and review the ILIT documents, ensuring that they complied with all applicable state and federal laws. We also provided guidance on the proper funding and administration of the ILIT, including providing Crummey letters to the beneficiaries of the trust.

Results & ROI

The implemented estate planning strategy yielded significant financial benefits for the client and their heirs.

• Increased Tax-Free Transfers: By strategically gifting assets using annual exclusions and a GRAT, and establishing an ILIT, the client increased the amount of assets that could be transferred tax-free to their heirs by an estimated $1 million. This increase reflects the $2 million in life insurance proceeds held within the ILIT which is now outside of the estate, minus the value of the assets used to fund it.
• Reduced Estate Tax Liability: Based on current projections, the estate tax liability was reduced by approximately $400,000 due to the removal of the life insurance proceeds from the taxable estate and the shifting of future appreciation out of the estate through the GRAT. This calculation is based on a 40% federal estate tax rate.
• Enhanced Liquidity: The $2 million life insurance policy within the ILIT provides a readily available source of cash to cover estate taxes, administrative expenses, and any other financial obligations, eliminating the need for the client's heirs to sell illiquid assets or take out loans.
• Asset Growth: The GRAT enabled further appreciation of the gifted assets within a tax-advantaged environment. The client projected an additional $200,000 of growth on the assets gifted to the GRAT, which will also be transferred to their children free of gift and estate tax.
• Peace of Mind: The client expressed significant relief and satisfaction knowing that their estate plan was comprehensive, up-to-date, and aligned with their financial goals.

Before the implementation of the new plan, the projected estate tax liability was $1.4 million. After the implementation, the projected liability fell to $1 million, a direct result of the strategic planning.

Key Takeaways

Here are key takeaways for other advisors from this case study:

1. Proactive Planning is Crucial: Don't wait until a client's estate is significantly over the exemption amount to begin planning. Early planning allows for more flexibility and maximizes the potential tax savings.
2. Diversify Estate Planning Strategies: Employ a combination of gifting, trusts, and other techniques to create a comprehensive and customized plan that addresses the client's specific needs and goals.
3. Leverage Technology for Enhanced Analysis: Utilize AI-powered tools and financial modeling software to conduct detailed actuarial analyses and project future outcomes, providing clients with data-driven insights and optimized strategies.
4. Stay Up-to-Date on Tax Laws: Keep abreast of changes in federal and state estate tax laws and regulations to ensure that your clients' estate plans are compliant and effective. Given the potential sunsetting of the higher exemption amount, this is especially critical.
5. Coordinate with Legal Professionals: Collaborate closely with experienced estate planning attorneys to ensure that all legal documents are properly drafted and executed, minimizing the risk of challenges or disputes.

About Golden Door Asset

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